E240: The Edge: Risk, Discipline, and Judgment in Venture

23:37And the more it aligns with your own intuition around that and the more self-aware and humble they are as a founder to be able to say those are the risks, that actually tends to correlate a lot with ambition because they're going in eyes wide open and still talking about taking the big swing. So it means they know the risk they're going to take, especially for hardware businesses, where it's hard to like pivot these things and just like white knuckle your way through it. It's really important to have that clarity of thought super early in the company, and then have that person be able to bring you as the investor along with them on the journey and make you feel like you're part of it.

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25:09And right now you can get up to$200 off Square hardware when you sign up at square.com slash go slash how I invest. That's S-Q-U-A-R-E.com slash go slash how I invest. With Square, you get all the tools to run your business with none of the contracts or complexity. Run your business smarter with Square. Get started today. I think a lot of people intuitively grasp what it means to be very disciplined. Everybody's had to go to school, turn in homework. A lot of people grasp this idea of chip on their shoulder. That's why so much of Silicon Valley is immigrant or second generation immigrant. Tell me about competitiveness.

25:46What exactly does that mean? And is this lack of competitiveness and is competitiveness a necessary factor for the power law outcome? Yeah. When we talk about kind of what we want our companies to be, how we, how we think about the culture within the companies we're trying to back and the founders. It's two parts that are equally important. We want founders and teams that have fun, first and foremost, but also play to win. So startups are hard. We didn't talk a ton about my background, but I ran a hard tech business for seven years. Took it from inception to series B, hired 30 people, built a 25 ,000 square foot pilot plant, threw all the ups and downs, managed you through COVID.

26:27If you're not having fun, it's very hard to do your best work. It is hard to attract great talent. It is hard to present well in front of customers. It is hard to raise capital. It's amazing how often that just shows through. But one can over-index on fun and just kind of have too much fun. And the way that is you focus on playing to win. It's not just about fun. It's about having fun, but understanding the goal we're playing towards is not we want to change the world. I think that's fine. Changing the world is an output of having fun and playing to win consistently over a long period of time.

27:02But playing to win is, hey, this project is due Friday. I know it's Tuesday. Get it done on Friday. And make sure you get it done on Friday. Why Friday? Well, because Friday allows us, if we get it done by there, we can move to the next thing next week. It's that little bit of competitiveness. Hey, we need to beat this other company for this customer because we just want to win. We want to create a culture of winning. And we're going to do it in a fun way that makes people want to keep coming back to work and staying until midnight and coming in on a Saturday or Sunday, that's a culture thing.

27:28But making sure that you kind of have both of those is critically important. And the competitiveness comes in in the play to win part. But doing it in a way that is like healthy and values aligned, I think is really important for longevity of these businesses. I think anyone that has a short term mindset on we need to win in a zero sum way in the short term, in the long term, that creates toxic culture that can create challenges in the business over time. so really building that strong foundation and bottom up that focuses on the fun part but also how do you win and being competitive against your competitors i wonder if this play to win could be reframed as the sense of urgency i was listening to a podcast about elon musk and he always creates these crazy senses of urgency so when he's at tesla he'll say every day in 10 years from now we're going to be at 100 million revenue or we're going to have 10 million revenue every day.

28:20So every day that we delay that, we're losing 10 million in revenue. So he has a way to basically bring the future forward and make that urgency today. Yeah. I think of urgency as a necessary precondition to winning big in the longterm, but urgency without direction and urgency without consideration for whether we're right is not enough. That's actually a recipe for burnout. Consistent urgency with no clear direction is a recipe for burnout. Understanding that what matters is winning, what matters is revenue, what matters is enterprise value growth, what matters is delivering products on time or ahead of schedule.

28:58Those are versions of winning. What matters is taking the late night interview to hire the engineer and you get them from your next competitor company. Those are clear quantitative measurements of victory. So while urgency is definitely the precondition for long-term big wins. There's this meme in Silicon Valley that burnout is not an effect of working too hard. It's an effect of working too hard for a long time with no progress. To what extent do you believe that to be true? I totally agree with it. I wrote a post about this maybe six months ago or something like that, where it's how to find your next job and what you're looking for in your next job.

29:37Three things that I highlighted in that post. One was you're seeking agency, the ability to make decisions. Number two, you want to understand how your work directly translates to economic outcomes for the company. And number three, you ideally want it to be something you're excited to tell your mom about whatever it is that you're working on. And if you have those three and you're doing those consistently, that's a great place to be. But if any one of those three either don't exist in the context of finding your next job, if you don't have any one of those three, keep looking. But I think in a company, if you lose any one of those three, it can be very easy to get burnt out when you're working hours and you don't know how your work is connected to the economics of the company.

30:22you're no longer proud to tell your mom about what you're doing, or you lose agency and you kind of just become a cog. The longer you can preserve those three things for your company internally, the faster you're going to compound as business. One of the things that Wall Street or the financial world completely underestimates is what I call the sixth gear. When you're going after something that has serious consequences for the world, like populating Mars, your brain and your body goes into sixth gear. It unlocks another sense of drive that you can't see in a spreadsheet. I can't show you in Excel and show you this is a sixth gear, this is a drive, but it very much affects the productivity and the output of the company.

31:01The sense of mission is something that I think Wall Street and people in finance kind of look down upon and think it's naive, but it is a direct line of sight to a higher returning asset from a purely asset allocation standpoint. Yeah. And I think the way that most often shows through would be through better employee retention. It would be through high recruitment success rates. It would be through faster delivery timelines. And all these things are, these are things that have outputs that investors understand, right? Fast inventory. So maybe it is in the spreadsheets. Yeah, it's in the spreadsheets.

31:35The second order effects are in there. The second order effects. This is a really interesting thread that you pull on with that though, because I think a lot of people understand the language in that second order effect, But the people that can truly drive alpha are the ones that understand the individual independent variables that are predictive of those more well-understood legible views of success. So if you can walk the floor of a factory in El Segundo and get a feel for whether or not this is a convex or concave type culture in terms of where it's going in six months, you can start betting today on that business confidently because you know how these variables are correlated.

32:13it. You know what the correlations look like. So the more time you spend in any area, look at the people who will tell you have they've been doing it for 30, 40 years. They can go walk a factory floor or they can go to an office and they can just kind of get a feel on what the direction of this company is six or 12 months down the line because they kind of know where to look. Talk about AI. AI is obviously affecting everything. How specifically is AI affecting the hard tech space? Is it more prominent? Is it less prominent? It's really three ways. First one is AI certainly accelerating the potential, the design cycles for a lot of hardware.

32:49I think that's really an interesting one that will accrue significant benefits to existing players that have kind of platforms that work and then they're doing their rev twos, their rev threes. If they could do that faster, it makes it harder for net new incumbents to kind of come in and be able to out-design them. That's one. I think the second is, you know, things that are like AI-driven control systems. You see this a lot in robotics where you can have extremely general purpose robotics, which would be the dream. I think that is the intersection of hardware and software where AI is kind of having an effect on the potential surface area of applicability in robotics.

33:23The third is edge use cases. So if you think like edge IoT sensors where you can have running AI locally on edge devices that can get much greater information, predictive intelligence with much lower power than you could have had before versus five years ago with what you had to do and stream the data straight to the cloud. If you can do AI at the edge, now all of a sudden, the predictive capabilities that you have for remote deployed systems and edge IoT, the ability to do responsiveness, all goes kind of parabolic, if you will, from a capability standpoint. Where does AI meet the hardware to this point?

34:03But that's where we've traditionally started to see it really play out. And you have this unenviable challenge of finding startups in the hard tech space before they really break out. What are those leading indicators that you're looking that might signal to you that this might be the next Andrel or SpaceX? It always starts with, do I think this founder can be the next Palmer Luckey or Trey Stevens to use Andrel or the next Elon? And I think that's always the archetype of, that's an example. Do you think, just to push back on that, do you think Palmer Luckey could have pivoted to another industry and been not successful?

34:39Obviously, he started a successful billion-dollar company before, but do you not think that the industry was really pulling him towards that? Do you think a combination, or do you think there's just those special founders that could succeed in anything? I think there are special founders who are talent magnets. And to come back to this idea of following founders into a burning building, you can bet there were tons of founders, tons of people that worked with Palmer, I worked with Trey, worked with Brian and Meckrim, she's Andrew Hill, or, you know, worked with Elon that followed them, whatever they were doing.

35:09And why did they do that? Well, because they trust that founder's judgment that this is a good problem, well-timed, that investors will fund this business, that they want to go on this very challenging journey with them. It's an engineering challenge that has a, that's very hard, but has a very clearly defined scope. I think a lot of these big companies started out that way, even rockets, right? You look at SpaceX in the early days, rockets were not new, right? It was, hey, we're going to make them commercial. It was a big challenge, but Elon was an inspirational leader to do that and have people come work for him to go after that problem, have a culture that pushed the envelope from an engineering perspective, which was naturally magnetic to the best people early on that wanted to go take that risk with him.

35:47For us, to your question, how do we identify people early? We want to understand who's following you. Why are they following you? What is your edge in getting those people to follow you, right? How do you articulate what that is? And it could be a track record. It could be, I worked on this. And then you can reference that. You can kind of through the network, try to understand like how real is that. And then you pair it with, Hey, are we building some small component and then we don't know what we're doing after that? Or is this company more about this person who has a vision for 10 or 15 years from now that is baked into what is almost an ideology at its core.

36:21It's an, the business is an idea. And anybody who works at this company is bought into that idea and is a worldview that they think is unique and they're excited to talk about and they convince others to believe in that over time. And that worldview monetizes through selling spacecraft or nuclear reactors or all these other kinds of things. But you have to kind of have that person at the top that can unfairly aggregate talent in an area that they have a unique perspective. And if you have those two things, then we can take that risk with them. But it's amazing how rare it is to find somebody that has a truly unique point of view paired with, I'll come back to this idea of like insane credibility from a track record standpoint.

36:58Said another way, the customer in the first stages of a hard tech startup is the engineer. There's a story, there's a Stanford professor and he said, there's a small company called SpaceX and they've recruited five of my top 10 engineers and Elon set up a meeting with him. And very early in the meeting, the professor figured out that Elon's trying to figure out who the other five top engineers are that went to SpaceX. So I think this ability to attract these top engineers is something, again, it also doesn't show up in the spreadsheets until a few years out. If you're Palmer Luckey, you're Trey Stevens, you're Elon Musk, it's easy, it's quote unquote, easy to attract that talent today.

37:38What about before they were brand names? What are some leading indicators of that? Yeah, I think I would say It's never easy to attract talent, but it's very easy. It's much easier when you've got people that you've worked with before that really love you. They find you to be inspirational and leader. So that's part of it. If you're still 18 years old, right, and maybe you don't have 10 years at a SpaceX that you could draw on people that you worked with in real commercial products, I think there are still evidence of leadership capabilities in people that if given enough time and patience will show themselves in the form of a company, if that's what that person wants to build.

38:18So, you know, is this person captain of the soccer team? Was this the person that people always came to when they had a problem? Can you ask them about some of that? You know, where did they grow up? Was it an entrepreneurial family? What did they learn from their parents that might have been entrepreneurs about doing this? What was it like? You know, who was what did their uncle do when they were growing up? And did they really live this idea that it is about people? And have they learned that being a great founder is really about being a great servant leader in many ways? You know, you're managing, in some cases, like heavy egos.

38:49If people are very talented, you're managing investors, you're managing customers, you're managing the vision of the business. And doing all of that means you are serving many masters as CEO. You are not the boss. You have many bosses. There can be micro causes of that, whether it's in athletics. It can be in, I used the term, I used Math Olympiad before, you can talk about that. What is the competitive or debate? I think there's archetypes of founders that were former debaters that are really amazing at articulating vision and making arguments. There are these little things early in one's life that can be highly predictive of the potential to build a great team.

39:24But make no mistake, it is hard for an 18-year-old kid to go recruit a 35-year-old senior engineer from SpaceX. That may just not be it. So it's about, okay, you have that potential, but what's the problem you're doing? How much capital is it going to take? How do you scope it? How do you de-risk it? How do you phase the milestones? That's a lot of where we end up spending a lot of our time. It's like, what's the right? Come back to where we started on risk management, portfolio construction. How do you structure this in a way so these companies can build momentum at the right speed and not build too much momentum too fast and they blow up, but set it in a way where they can build momentum over time consistently at the right speed for them?

40:01let's say you are that 18 year old would you advise them to go work at a hard tech startup and build those coalitions and build that team or should they white knuckle their way through the first couple years because one of the things i worry about for that 18 year old is to quote the zero billion versus zero million dollar startup which is in the first year you could set up your startup in such a way that it could never be a unicorn it could never be world class how do you think about that and have you seen people kind of up level their team after having a weak team from the start?

40:33I think it's very hard to change team culture after the first five people. But I don't think there's only one culture that builds a generational company. If I use hard tech companies, like I'm sitting here at Varda, I think we went clean sheet to recovered capsule in three years. That doesn't happen with people who've never done this before. It just doesn't. There's risks that this team didn't have to take because they'd done them before. There's experience, there's trust built that allows people to just move faster, get it right the first time. So for this company, that team dynamic was right to achieve a fast milestone.

41:16For a different business, let's use a software business where a lot of the moat will be from iterative development and learning over time what the customer needs and the faster development cycles you can have, the sooner you might be able to get to a durable moat. That could favor, you know, that may not, you may not need as much experience building spacecraft, for example. You just need to have a motor that can go really fast. So I have this example, this framework I use of kind of like RPMs and gears, right? You can back high RPM founders that maybe aren't kicking it into gear. So they'll spin, they got a lot of energy, but they may not quite go as far as somebody who spins at 3 ,000 RPMs in a higher gear.

41:59But it's more expensive. It's more energy to be in higher gear and do some of that. So you think about Avarda, this team came in super high gear and high RPM. So they went real far, real fast. We have other companies that maybe are still in learning mode, iterating, so lower gear, but still high RPM. So they're moving. They're just not moving nearly as far, but they're not spending as much money. They're not in as high a gear, not as high a burn to be able to get that learning. Tell us further, explain what it means to be high RPM and high gear. Yeah, so high gear would be, we're burning a lot of capital, right?

42:38We're spending a lot of money, which means the stakes are higher to be right, especially per unit time. If I'm high RPM, it means I'm iterating quickly and I'm evolving quickly. So if I'm iterating, it becomes important if you have a high gear, high burn, that you're right. And you're much more likely to be right if you have a little more experience and you're building in a space where the experience is directly valuable, right? Like it's not, you know, building a space capsule is not a mystery. People have done it before, but you want to do it right. So there's high burn, but you got to build it right, but it's not a mystery.

43:09If you're doing a software business or a consumer app, like you can't have high burn for that because you just kind of got to iterate and navigate the idea maze and through the uncertainty. So you want to have fast iteration cycles, but you want to keep burn low until you figure it out. And then you kick it into gear and maintain high RPM, right? A lot of hard tech companies end up high gear, high RPM early on. And the ones that get it right, they go really far. The ones that struggle are either low RPM, high gear, or low gear, high RPM. So they're just not really going that far and they get behind.

43:42Set another way in software, you want to get product market fit. So you talk to customers, you figure out the right product, then you raise a bunch of money and you just copy paste. You go from one salesperson to town salesperson. There's no technical invention that needs to be made to get from 1 million to 100 million. Then there's just a sense for how big the market is and other competitive forces. In hard tech, why is it different? Give me a specific example. Yeah, in hard tech, these things are not mysteries. It's, hey, we've got a company, K2Space. They're doing some very innovative stuff, integrating components and subsystems that have been built in-house, building an entire supply chain.

44:19But they are building satellite bus. People know how to build satellite buses. They know what to use satellite buses for. They know what they could do if they had more power or bigger bus or could get more to mid-Earth orbit faster. That stuff's not a mystery. What's hard is the execution, raising the capital, articulating the long-term, hiring the specialty expertise across systems engineering and thermal management and software and avionics and ops and biz dev. and government and doing all of that in advance of revenue. That's a hard problem to solve. But the idea is if you can bring talent and capital together and time the market right and have a unique insight on why you should bring the talent and capital together to go after this market, it's hard to replicate that.

45:03So it becomes high gear, big bet. The caliber of founder it takes to do that type of a company has to be exceptionally large, exceptionally high. That's why Blake building to use Blake and Boom. He was successful. He had successes before. High caliber founder to be able to take that kind of a swing. Not everybody can take that kind of a high gear swing. That's what's unique about this. There's not as much mystery in some of these. Sometimes they'll iterate on the business model a little bit and try to figure out exactly where we're going to get paid and how much we're going to get paid and on what time frame.

45:34But most often we're not taking a bunch of science risk on can we make a fusion magnet work in this time frame. You've been in ventures since 2016. roughly nine years ago. What is one single piece of advice, timeless advice, that you wish you knew when you started that would have either accelerated your career or helped you avoid mistakes?

46:03You don't have to be in every great deal. You just have to be in a handful of really good ones and own a lot of them. I think early on, there was a lot of chasing. There was a lot of, you know, need to see this. Like, how do I see this? I want to see that. Over time, I've learned to be a long-term partner to founders and do things that are useful to the great people in your network. And with time, you will have a right to see great people and write them early checks that are meaningful. That's really what this game is about is the daily behaviors need to be magnetic to great people. And then you need to structure your capital and your approach and your strategy in a way that you can bet meaningfully on those people when those opportunities arise.

46:52The best opportunities we had in one way were serendipitous, but the serendipity was definitely correlated with the day-to-day activities of how we were spending time with people, being naturally curious, being helpful to people and staying in touch. And then those things coming around, staying top of mind through social awareness and other kinds of things that make people think of you. those things all kind of add together to say, hey, look, you don't need to chase every deal because you can build a reputation of someone who chases. And that's not how you get into great deals at great prices and get invited to participate with really awesome investors.

47:24How you do that is if you're disciplined, brand has signal, you do independent work with rigor, and you bet on your people. And you're really betting on the quality of your network. I think that was a realization for me years ago. I said, our network is what it is. I think it's going to continue to get better and better, but let's bet on the people. Let them pull us up. I think that realization really gave me clarity of mind for how we were now performing in the long term and just let it compound over a long period of time. Same thing could be a really good thing or a bad thing depending on how you label it.

47:56Chasing deals. I understand there's a negative connotation to that, that you're literally chasing a deal. But what does that even mean? How do you know that you're chasing a deal? You know, it's a thing. It's a, hey, have you heard of this company? Okay, should I go find out? They're doing a round. They have the lead investor. They have this thing. They're doing a round. they have this thing or like this person starting a thing. It's like, okay, so should I go try to get in touch with them, find out what they're doing. And it's not that in a vacuum. It's that ideally in venture, you're kind of as disciplined and systematic as you can be.

48:26So if you're willing to do that one time, you should be willing to do that lots of times. And if you do that as a recurring behavior, it can take up a lot of your energy. And the output of that most often tends to be, you know, you pay a more full, you know, high price. You have more kind of, you're really looking more at an auction, which makes it harder for you to really have good information. You don't have the time most likely to get to know the founder. And if your model is, to my point of like, we underwrite founders, like really wanting to understand them and their track record. it's really hard to do that well if your 40 % of your book is in deals that you're chasing instead of having 80 % of your book in deals where you're getting to know people.

49:10And then coming back to the risk you're willing to take, like maybe we take a risk where like the initial TAM is not clear or not obviously large, but we're betting the founder has enough ambition to go expand it. Right. Maybe we're taking the risk that like there's two other companies that people would say are kind of competitive to this. But we think this founder is compelling enough that the team they're going to build is going to make them viable. And we'll take that risk alongside them and get paid well when we're right. I think that is how we think about where we're most comfortable. And it's also a function of how we're set up, right?

49:39Solo GP, it's me and one full-time analyst. That's it. We're resource constrained, which means we have to be disciplined in the box that we kind of look for in how we play our game. In an infinite resources of capital and time, you might chase deals. But given that you have both finite capital, you need to chase alpha and finite time, you have to focus on the deals that you have the highest likelihood of winning. That's right. But I think there's also a second piece, David, where I think success in venture is very, it's reflexive to a degree. How many great venture firms do you get to know? It's like venture firm X, they were the first investor in Y.

50:15And anybody who's building something that is like adjacent to Y will call venture investor X, right? The more deals you do, the more you average your signal towards the average performance of those deals. The fewer deals you do, the more your signal is the average of the good performers that you have in your portfolio. So it's interesting. This is interesting dissonance because the math says do a lot of deals. But the math also says a few number of companies, like an Elon, drive all the returns, right? An Anderil, right? So what behavior gets you exposure to an Elon? What behavior gets you exposure to an Android?

50:53It's probably being more disciplined on the volume of stuff that you're doing. So your brand has signal because the best people want signal to solve what problem? Hiring great engineers, raising great following capital to go after significantly ambitious problems. So we've kind of chosen to say like, we know the math. We get what the math would say in terms of like invest in a lot of deals. But we also know that the math says a couple companies matter. And when you unpack the founders of those couple companies, most times you wouldn't have access to them unless you were in a network of people that had a density of outliers.

51:25So we've chosen to say, how do we optimize to be in a network that has a high density of outliers and ride with those people? We'll go as far as they'll take us. I have somewhat of a paradoxical belief. A lot of people think that it's unknowable at pre-seed. I call it complete bullshit. And here's why some of the best portfolios of all time, two of the best funds ever were not funds. They were David Sachs' angel portfolio and Mark Andreessen's angel portfolio. Why? Because they knew these people. Therefore, they weren't knowable. Maybe you could say, well, maybe you had to work with them for five years, and therefore it's not very scalable.

51:58But it is knowable. That doesn't mean that every investment that you make, you have a 90 % chance of success. It might be 10 % versus 2%, or it might be 7 % versus 2%. But there is a significant edge on doing the work and knowing the people that I think a lot of people dismiss as some kind of playing the lottery. And I think that's an unsophisticated and lazy view on market. That's right. I think it's also what work you do, David. I think if it's, hey, we did the work on the market and we read the Bain report and the McKinsey report. It's like if you're reading a Bain or McKinsey report at Preseed, you've already lost.

52:28But did you do the work on the person to understand what motivated them? What story? Who wronged them or who inspires them? And really understand how you tell that story. We've got a founder whose motivation is to retire his mom who came to the US from Eastern Europe and was a doctor there and had to go to med school again in the US to get a degree. And his dad passed when he was younger. And the mom raised him and the sister. And it's this amazing story that you realize, what's the fuel to keep going? That's actually a scarce resource. There's the fuel to keep going. if you can identify that really early, like these are the types of things you're trying to find in founders that can go the distance.

53:10A society becomes richer and the bottom floor keeps on going up and now everybody's well-fed, everybody has good schooling, everybody has good healthcare. That edge becomes even more important because what is going to fuel that founder to stay up and spend 18 hours a day if they have all their basic needs taken? You need that chip on the shoulder. You need that ultimate purpose that's kind of pulling them away from their comfort. Mike, this has been an absolute masterclass in deep tech and nerding out on how to find the next Elon Musk, the next Palmer Luckey, the next Trace Stevens. Thanks so much for jumping on the podcast.

53:43Look forward to continuing the conversation live. Thanks for having me, David.

54:00these conversations week after week. Thank you for your continued support.